While the entire market has sold off this year, the chip sector has taken a big downturn, especially in the past few weeks. More aggressive rate increases from the Federal Reserve have prompted concerns of a recession, which is never a great thing for semiconductor sales.
Yet while consumer electronics bought during the pandemic, such as PCs and phones, are seeing a downturn, it appears auto and industrial chip demand remains robust. According to Trendforce, the auto sector is the only chip end-market still currently seeing "strong demand" for power management chips. According to Market Future Research, the auto chip sector is set to see 12.3% annualized rate through 2028, as more electrified and autonomous vehicles require more and more chips with each passing year. Meanwhile, labor shortages and the desire to bring manufacturing capacity back onto U.S. and European shores has boosted demand for industrial automation chips.
With the whole chip sector down for the count on recession fears, these auto and industrial-focused chipmakers looks like tantalizing buys.
Texas Instruments
Blue-chip semiconductor giant Texas Instruments (TXN 5.64%) is trading back at a P/E ratio of 17.8 and its dividend yield is near 3% -- near the lowest valuation and highest dividend yield the stock has seen over the past 10 years, with exception of late 2015 and late 2018.
TXN PE Ratio data by YCharts
Texas Instruments is a very broad and diversified company, and it also has low-cost 300mm wafer manufacturing capability, giving it a competitive advantage in producing a wide array of analog and embedded chips. Analog chips are those that transfer inputs from the physical world, such as heat or pressure, into digital signals, and vice versa. Its embedded chips are largely microcontrollers, which are small low-powered computing chips that perform a specific function inside machines.
Texas Instruments has been around since 1930 and has obviously had to pivot its product portfolio several times to thrive for that long. In recent years, TI has concentrated on industrial and auto chips, with industrial chips making up 42% and auto chips making up 21% of 2021 revenue. That 62% combined allocation is up from 42% in 2013.
That focus allowed TI to grow 14% last quarter, although growth is still being hampered by supply constraints. Fortunately, the company has a large fab coming online later this year, another one ramping in early 2023, and a massive four-fab complex that just broke ground, which is expected to come online in 2025.
That's a lot of capacity coming online, and Texas Instruments is usually very prudent about capital allocation. The capacity increase should mean robust revenue growth that looks to extend for this decade. With incredibly high operating margins of 51% over the past 12 months, shareholders can look forward to increasing dividends and repurchases at these beaten-down levels.
On Semiconductor
Another leader in power management and silicon carbide chips, with specialized solutions for the auto sector specifically, is On Semiconductor (ON 6.24%).
On Semi has made a company-specific transformation over the past two years, ever since an activist investor got involved with the company in late 2020. Back then, Starboard Value thought On Semi's cost structure could be improved by consolidating its manufacturing footprint and exiting low-margin consumer chip businesses to focus on higher-margin auto and industrial chips.
After Starboard got two board seats and new CEO Hassane El-Khoury came on board that year, On has done just that. Since 2020, gross margin has increased from 32.7% to 49.4% last quarter, while adjusted (non-GAAP) operating margin has more than tripled to 33.9%.
On the recent earnings release, El-Khoury said, "With a highly differentiated portfolio of intelligent power and sensing products, strong visibility driven by long-term supply agreements, and exposure to secular megatrends of vehicle electrification, ADAS [advanced driver assistance systems], energy infrastructure, and factory automation, we are well positioned to sustain our momentum."
Overall revenue was up 31% last quarter, but the high-focus areas of auto and industrial chips were up a higher 42%, and now make up 65% of revenue. On Semi has a goal of reaching a 75% auto and industrial makeup by 2025, so further gains and margin expansion could be ahead as high-margin auto and industrial chips make up a greater portion of the pie.
After the sell-off, On Semi trades at a bargain-level 11 times this year's earnings estimates, reflecting a recession. Yet with a slowdown already priced in, On Semi seems awfully cheap for a stock set to grew over the long term.
NXP Semiconductor
Like On Semi, NXP Semiconductor (NXPI 4.18%) also seems awfully cheap, at just 11.6 times this year's earnings estimates. NXP has the highest concentration in auto and industrial chips, with 50% auto and 22% industrial and IoT chips, making up a combined 72% of revenues already. The remaining revenues are mainly in mobile secure communications, along with 5G communications infrastructure. Last quarter, NXP showed solid 22.2% growth, higher than Texas Instruments, but lower than On Semi; however, NXP is more where On Semi is trying to go, with gross margins already in the high-50% range.
NXP's focus is on sensing and imaging, with an exciting imaging radar processor now in 20 top auto manufacturers. Radar should be a key part of autonomous vehicles, from the Level 2 capabilities most new cars have today, all the way to Level 5 fully autonomous vehicles. Other accelerated growth drivers in auto include domain and zonal processors, as well as electrification systems.
All this should help fuel growth between 8% and 12% annually for the next three years, with margin expansion, according to NXP's long-term model. No wonder the company was comfortable raising its dividend by a whopping 50% last quarter, which now yields a nice 2.1%, along with share repurchases.
If that weren't enough, recent rumors have it that South Korean tech giant Samsung wants to acquire NXP. Given that NXP has sold off so much, any offer could lead to a quick gain. However, investors shouldn't count on a buyout for a quick buck, as the deal might have trouble getting approved. Still, NXP looks like a solid value to hold through the autonomous and electrification transition over the course of this decade, whether it gets acquired or not.
